Thursday, January 15, 2009

Retail Memo: Natural-Organic Foods and U.S. Retail Marketplace Realities; Why the FTC's Case Against the Whole Foods-Wild Oats Merger is Pure Folly

Analysis: FTC v. Whole Foods Market, Inc.

Natural~Specialty Foods Memo (NSFM) believes the U.S. Federal Trade Commission's (FTC) legal case and argument against the merger of Wild Oats Market, Inc. and Whole Foods Market, Inc., the friendly acquisition by Whole Foods of Wild Oats that the regulator has been fighting in court since the summer of 2007, is folly.

NSFM has no affiliation with Whole Foods Market. We have nothing to gain from the merger's holding firm. In fact we think part of the reason the FTC continues to so strongly oppose the deal, despite the fact its been over 18 months since it was done and is now near fully-completed in terms of integration, is because of the decade-plus public comments of Whole Foods' CEO John Mackey and a couple of other company executives about "dominating" natural foods retailing in the U.S.

We also think part of the reason for the FTC's resolve has to do with John Mackey's silly postings on Yahoo Finance message boards during the run up to the deal in which using an assumed screename he described Wild Oats essentially as a bankrupt company in need of a new owner; that new owner being of coourse Whole Foods Market, Inc. We happen to agree with Mackey that Wild Oats was basically that, as do most of the investors who were four-sqaure behind the deal with Whole Foods, but his method of communicating that opinion was less than stellar. Mackey was investigated by the federal government for the postings and was foound to have broken no laws.

However, neither of these are or should be valid reasons for the FTC to continue to challenge the merger, assuming as we suggest they might play a part in the regulator's doing so.

The FTC's central argument against the deal is that a combined Whole Foods-Wild Oats is a monopoly retailer in 29 U.S. markets in what the regulatory agency has termed the "premium natural and organic foods retailing segment." As a result the FTC says Whole Foods Market, Inc. presents an anticompetitive position vis-avis other retailers in the selling of natural and organic foods in these U.S. markets.

The creation of this food retailing segment by the FTC forms the entire central premise of its ongoing attempt to unwind the merger.

But the problem is the "premium natural and organic food retailing segment" is at best irrelevant and at worse a creative fiction in terms of the retailing of natural and organic foods and related consumer goods in today's U.S. market.

Instead, natural and organic foods retailing in today's America is what we call a multi-retailer and multi-format business.

At one end of this spectrum there are serious and strong regional competitors in the natural-organic retailing class of trade that are dealing a serious blow to Whole Foods Market, Inc. These retailers include such regional natural foods chains as Sunflower Farmers Market, Sprouts Farmers Market, Henry's Marketplace (which Whole Foods sold to Smart & Final, Inc. after acquiring it in the Wild Oats deal in 2007, Natural Grocers by Vitamin Cottage, PCC Natural Foods Co-op (Washington State) and New Seasons Market (Portland, Oregon Metro region) and a number of others in the Western U.S.

Elsewhere in the U.S. other fast-growing natural foods chains like Mrs. Green's Market (New York state region), which is owned by Canada's Planet Organic, Inc., Earth Fare (southern U.S.), Fresh & Wholesome (eastern U.S.) My Organic Market (Washington D.C./Maryland/Virginia region) and others are strongly competiting against Whole Foods in those and other U.S. regions.

Further, along with these small but in most cases fast-growing natural and organic foods chains, there are thousands of independent and co-op natural foods stores that competite head-to-head with Whole Foods stores in their respective U.S. markets.

Along with the natural foods class of trade described above, the biggest development in category retailing in the last decade has been the entry of supermarkets into natural and organic products retailing. This includes mega-chains like Safeway Stores, Inc. with its Lifestyle format supermarkets (1,750 in the U.S. and Canada and growing), Kroger Co., including its new "Fresh" format, as well as mega-regional chains like H-E-B in Texas, Publix in Florida, Raley's in Northern California, Wegemans on the east coast and so many others. These retailer's stores offer nearly as much variety of natural and organic food and grocery products as a Whole Foods market does and generally offer the category items at a lower everyday price that Whole Foods does.

But the supermarket class of trade's major and fast-growing position in natural and organic foods retailing isn't all there is in terms of the competitive landscape today in the U.S. Huge mass merchandisers like Wal-Mart, Target, Wal-Mart's Sam's Club, Costco, B.J's Wholesale and other national mass merchandiser chains are in the natural and organic products retailing business in a major and serious way.

For example, all of the mass merchandisers mentioned above offer their own private label brands of natural and organic foods, selling the products a lower everyday prices than Whole Foods stores do. These retailers also offer organic foods and consumer packaged goods marketed by national and regional manufactuers (brands), as well as selling organic fresh produce, meats and other perishables in their respective stores.

On top of all this competition are what we call the discount and hybrid natural and organic foods retailers. This category includes the mighty Trader Joe's, which with about 312 small-format disount natural and specialty foods stores throughout the U.S. is a major force in natural and organic products retailing. Trader Joe's is a natural-organic category killer retailer and steals much market share away from Whole Foods throughout the country.

Examples of the hybrid category include Cost Plus World Market which sells lots of natural and organic food products in its nearly 300 combination specialty foods and imported consumer goods stores located throughout the U.S. In the last couple years Cost-Plus has created numerous natural and organic food products across all categories under its World Market store brand, becoming a competitor for share of stomach with Whole Foods Market and all of the other retailers in the U.S. that retail natural-organic category products in their stores, regardless of format.

Another hybrid is the fast-growing Fresh & Easy Neighborhood Market, which is owned by United Kingdom-based Tesco, the third-largest retailer in the World. (Wal-Mart is the number one global retailer and France's Carrefour is number two. In just a little over a year, Tesco has opened about 110 of its small-format Fresh & Easy combination fresh foods and grocery markets in Southern California, Nevada and Arizona, with more to come. Along with selling basic grocery items and lots of fresh, prepared foods, including organics, the stores offer a solid selection of natural and organic packaged foods, groceries and perishables under its fresh & easy store brand. The natural and organic items are priced below those at natural foods stores like Whole Foods Market and are designed to steal away business from Whole Foods and traditional supermarkets.

Another hybrid retailer is Beverages & More, which has numerous stores throughout the Western U.S. The stores are beer, wine, spirits and specialty and natural foods category killers, offering items in each of these respective categories at discount prices. Every package of organic cereal, bottle of Vitamin Water or jar of organic mustard bought at a Beverages & More store could have been purchased at the monopolistic Whole Foods, for example.There are numerous other examples of hybrids located throughout the U.S.

There also are what we call hybrid upscale/specialty/natural foods superstores. These retailers include regional chains such as Fresh Market in the southern and Mid-Atlantic regions of the U.S., United Supermarkets' Market Street chain in Texas, Supervalu, Inc.'s Bristol Farms in California and numerous others. They retail specialty, natural and fresh foods, along with basic groceries, in very upscale (every bit as upscale as Whole Foods) stores ranging from 30,000 -to- 60,000 square feet, putting an emphasis on most of the same categories and practices that Whole Foods focuses on.

But we aren't finished yet with our natural-organic category retailing competitive review. In addition to all of the competition we've detailed above, American consumers can today buy natural and organic food and grocery products at drug stores owned by huge chains like Walgreens, CVS and Rite Aid, at 99 cent and dollar stores, online through retailers like and others, and in the case of organic fresh produce at thousands of farmers markets across the U.S. Although these alternative channels offer limited item selections, taken with the retailers described above they add significantly the the competitive natural-organic retailing landscape in the U.S. today.

The point is, looking at natural-organic products retailing through the blurred lense the FTC is using -- its "premium natural and organic retailing segment (PNOS)" -- is like the old philosophical saying of failing to see the forest through the trees. Create a definition, PNOS, and then use that non-realistic definition of today's market as the basis for your argument against the merger is how we view what the FTC is doing in continuing to oppose the Whole Foods-Wild Oats merger under this framework.

But this is not merely our analysis or opinion. The marketplace agrees with us. For example, Sunflower Farmers Market and Sprouts Farmers Market both last year raised tens of millions of dollars to expand their respective businesses and store counts, which both chains have been doing aggressively. Both natural foods chains, as is the Natural Grocers By Vitamin Cottage natural foods chain, are going right at Whole Foods Market, opening stores in its home state of Texas, along with taking Whole Foods on in Colorado, California, New Mexico, Utah, Arizona, Nevada and elsewhere. Would these retailers really risk this if they believed Whole Foods held category retail monopoly power? Of course they wouldn't. Many of the states mentioned above are part of the 29 in which the FTC says Whole Foods Market, Inc. post-merger holds a monopoly, by the way.

Add to this market-based evidence Safeway Stores' march into the natural and organic foods retailing business over the last few years. The national supermarket chain, which has about seven times the annual gross sales of Whole Foods Market, Inc., has converted nearly all of its about 1,750 (Whole Foods has about 280 stores) supermarkets in the U.S. into its upscale Lifestyle format, which among other things puts a major emphasis on natural, organic and prepared foods, which are the three key merhcandising pillars of Whole Foods' business. Safeway has had huge success doing so.

For example, a little over years ago Safeway introduced its "O' Organics" store brand of organic food, grocery and non-foods items. Today the brand has over $500 million in annual sales and is growing fast. It's estimated 2008 sales will be about $700 million for the brand. O' Organics sales are growing so fast in fact that Safeway is in the process of marketing the brand to competitor supermarket chains in the U.S., along with marketing it globally. France's Carrefour is already selling numerous "O' Organics" brand items in its stores in Asia and Central America, for example.

Just over a year ago Safeway introduced its "Eating Right" store brand of healthy foods. The brand includes natural and healthy products across all categories, from dry grocery and dairly to fresh produce. Sales of the brand already are at about $300 million. Safeway says first year sales of 'Eating Right" were even higher than those of "O' Organics." The supermarket chain also is in the process of marketing "Eating Right" to competitor retailers, along with doing so to global chains outside the U.S.

Does anybody really believe that a significant portion of this nearly $1 billion worth of annual sales in just these two Safeway natural, healthy and organic store brands didn't in part come out of the sales hide of Whole Foods? Of course it did. Shoppers who just a decade ago had to seek out Whole Foods and otehr natural foods retailers for such items can now find most all they need in the natural and organic categories at supermarket chains like Safeway.

Many of Safeway's newest Lifestyle format supermarkets look very similar in upscale design and product selection to a Whole Foods natural foods supestore. However Safeway's stores have the added benefit of selling conventional food and grocery products along with the natural-organic.

It's our analysis that the FTC either has failed to understand the dynamics and realities of how natural and organic foods are retailed today in the U.S. or that it intentionally has decided it wants to break-up the Whole Foods-Wild Oats merger for reasons other than actual real competitive ones. In looking at Whole Foods' performance since the deal was finalized in late 2007, there is zero evidence of a monopolist at work. Just some of the empirical and performance-based evidence that Whole Foods looks not like a monopoly but rather more like a struggling retailer:

>Whole Foods' income was down by about 40% in its last quarter. It had a similar drop in net income the previous quarter.
>Whole Foods' stock share price is off by about 70% compared to its high after the Wild Oats merger.
>In the last quarter of 2008 Whole Foods fired about 100 workers at its Austin, Texas headquarters in order to conserve operating cash on hand.
>In December, 2008 Whole Foods sold 17% of the company to private equity firm Leonard Green & Partners for a mere $465 million because it needs the cash. One year ago a 17% stake in Whole Foods was worth more than double that $465 million.

In addition to all the evidence we've presented in this piece, there's a far more simple and telling test as to why a combined Whole Foods-Wild Oats isn't a monopolist retailer of any sort. That test is that not one natural foods chain -- not Sunflower, not Sprouts, not Henry's -- or even an independent we've been able to find -- has spoken out publicly, saying that a combined Whole Foods-Wild Oats is a monopolist and because of it that retailer can't compete. Even when the merger was first announced, and when the FTC first issued its formal opposition to the deal in the summer of 2007, did we hear any natural foods retailers speak out and say they felt seriously threatened by a combined Whole Foods-Wild Oats. Instead there has been a deafening silence of concern from natural foods retailers over any real anti-competitive aspects of a combined Whole Foods-Wild Oats.

As we write this, Whole Foods Market, Inc.'s energy is being near-used-up fighting its legal case against the FTC, rather than in doing food retailing. Meanwhile, the combination of the severe recession and the competitive environment, in which all of the various format retailers we've discuss are in many cases offering natural and organic food and grocery products at prices considerably below Whole Foods, is taking a toll on the company.

For example, last week supermarket industry investor Ron Burkle bought a 7% stake in Whole Foods Market, Inc. through his Yucaipa Cos. investment and private equity firm, saying he believes the natural grocery chain is undervalued based on its problems with the FTC and in the current bad economy. The last time Burkle said something similar was when he bought an 18% stake in Wild Oats, and then as a powerful member of Wild Oats' board he played a major role in engineering the merger with Whole Foods. Could he have a similar plan in mind with his 7% Whole Foods stake? Investors think so. After Burkle disclosed his stake in Whole Foods last Thursday the company's stock rose by 23%. Its still down about 52% over a year ago though.

With Ron Burkle's 7% stake and Leonard Green & Partners' 17% stake in Whole Foods, that now puts 24% of the natural grocery chain's ownership in the hands of just two entities. Leonard Green & Partners also placed three people on Whole Foods' board as a result of its investment. A 24% ownership isn't a majority but its enough to play a major role in engineering an acquisition or merger should Burkle and Leonard Green & Partners, both of which are based in Southern California, decide to get together and talk potential deal creation.

We wonder if the FTC would cry monopoly for example if Safeway Stores, Inc. or Kroger Co. acquired Whole Foods? What about Wal-Mart or Target? After all, none of these mega- retailers, all of which are super-giants in terms of annual sales compared to Whole Foods Market, Inc., aren't technically players in the "premium natural and organic retailing segment." Therefore, adding a mere 280 stores and a little over $6 billion (Whole Foods annual sales) wouldn't, using the FTC's logic and argument against why a combined Whole Foods-Wild Oats is a monopoly, make any of these retailers monopolistic, not even Kroger which has about 12 times Whole Foods' annual sales or Wal-Mart, which has about 50 times Whole Foods' annual sales, right?

Therein lies the folly of the FTC's argument. It's created a fiction it calls the "premium natural and organic retailing segment," then used that non-market-reality-based definition to argue a combined Whole Foods-Wild Oats is a "category monopoly," leaving out the fact that the reality of natural and organic foods retailing today is what we've described it as -- a multi-retailer, multi-format, highly competitive business in which no one retailer, including Whole Foods Market, Inc., at present holds any type of monopoly. And in select markets where one retailer might monopolize category business to a certain degree, be it Wal-Mart, Safeway or Whole Foods, the effect is so minimal as to be irrelevant.

Even more significant is that nature of food and grocery retailing in the U.S. is so dynamic that something new -- think Sunflower, Sprouts, Tesco's Fresh & Easy -- all of which didn't exist in any significantly competitive way three years ago -- keeps coming along and changes the dynamics of the market. That's the true competitive reality of natural and organic foods retailing in the U.S. today.

1 comment:

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